Estate and Tax Planning February 2004

In This Issue:
- Maximizing Exemptions
- Yes, You Should Make Gifts
- Current Events at the Firm

Last month the Internal Revenue Service ruled favorably on a plan to effectively maximize the aggregate exemption of married taxpayers. In Private Letter Ruling 200403094, the Service allowed the estate tax exemption of the first spouse to die to shelter assets the surviving spouse had placed in trust. His assets; her exemption.

A Private Letter Ruling ("PLR") affects only the taxpayer who applied for it. Nevertheless, it can provide guidance as to the Service's current position, and the principles supporting this PLR appear to be sound.

In PLR 200403094, the wealthier spouse created a trust without making a completed gift; he had retained the trust income and a power to amend or revoke the trust. He gave his spouse only a general testamentary power to appoint an amount equal to her available exemption if she died first. That was enough.

If his spouse died first, the trust assets subject to her power would be included in her estate for estate tax purposes, the Service said. It made no difference that she had never owned or enjoyed the trust property. Because of the power of appointment, she controlled the disposition of those assets and her exemption could then be applied to determine the appropriate tax in her estate.

A revocable trust is an arrangement simple to incorporate in an estate plan. No gift or income tax return is required, and the trust can be revised or revoked quickly. Yet PLR 200403094 suggests such a trust can save substantial estate taxes for a married couple under appropriate circumstances: as much as 48% of the current exemption equivalent of $1,500,000.

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Yes, You Should Make Gifts

When a New York resident dies, his or her estate could pay an estate tax to both the Federal government and the State of New York. While the rate of each tax has always differed, the exemption from tax has been the same in recent years. Starting in 2004, these exemptions will differ. The obvious question is whether one estate planning strategy used currently by many New York residents for minimizing tax should be adjusted.

Specifically, what about making gifts? Gifts by a parent to his or her children are encouraged by the tax law because the capital gain tax (and even the estate tax) on future appreciation is shifted to the children. It is generally presumed that a child will have fewer assets and so pay estate tax at a lower marginal rate after applying the child's own exemption.

Are gifts still good? Yes. They are even more effective in many estate plans because the exemption for Federal estate tax is now higher than the exemption for New York estate tax.

The Federal estate tax exemption is now increased to $1,500,000 but the Federal gift tax exemption remains at $1,000,000. The New York estate tax exemption is $1,000,000 and the New York gift tax has been repealed. If a New York resident with an estate of $10,000,000, a spouse and three children makes a gift during her lifetime of $500,000, she will pay no Federal gift tax under current law. Instead, her available gift and estate tax exemptions will be reduced by $500,000, dropping to $1,000,000 for estate tax purposes and $500,000 for gift tax purposes. She will pay no New York gift tax because that tax has been eliminated. At death, the New York resident will have a Federal estate tax exemption of $1,000,000 and a New York estate tax exemption that is unchanged by the gift at $1,000,000.

In all probability, this New Yorker's plan had been to leave the amount of her exemption from estate tax to her children or in a trust designed to "by-pass" her surviving spouse's estate with the balance of her property to be left outright to the spouse or in a marital deduction trust for his benefit. That is still a good plan for many spouses, one made better by the gift.

Assume the New York resident does not make the $500,000 gift, and her Will has directed $1,500,000 to the children or to the by-pass trust under a formula clause referencing the available Federal exemption. The New York estate tax would have applied to tax $500,000 of that bequest, resulting in a tax payable of $64,400. Further, this New York estate tax could not be paid from the bequest to the spouse without Federal and New York estate tax being assessed on the amount of the New York estate tax due. The New York tax would have to come from the amount going to the children or the by-pass trust. The result would be that, although her surviving spouse receives the same amount at death, the children (or the by-pass trust for their benefit) would receive less than $1,500,000. However, if the $500,000 gift had been made, the children or the by-pass trust would receive the full amount.

For anyone inclined to make gifts, we would be pleased to help reduce estate taxes by preparing the deed, transfer instructions or trust agreement, and the gift tax return to secure the appropriate value for the property.

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Current Events at the Dunnington Firm:

C. Frederick Rogge, III joined the Firm as a Partner on June 1, 2003. Fred graduated from Columbia University School of Law in 1968, and received an LLM in Taxation from New York University in 1971. Most recently he was a Partner for 15 years at Jackson & Nash, LLP. Fred continues to specialize in estate planning and the administration of estates and trusts in the Firm's Estates, Trusts and Private Clients practice group, and will also work on a variety of matters including dispositions of interests in oil and gas properties, domestic and foreign private foundations, and issues affecting foreign investors in the U.S. marketplace. Fred served on the editorial board of Practical Drafting in the early years of that publication, and was the principal draftsman of this edition of our Report to Clients.

Michael J. Kopcsak has returned as a Partner on January 1, 2004, after serving as general counsel to two large international communications companies for 13 years. Mike will be active in the Firm's Litigation and Corporate practice groups. He has significant experience in corporate transactions, particularly in the international context, and with respect to advertising and other service businesses. Mike has handled a wide variety of commercial and litigation matters over the years and has expertise in partnerships, joint ventures and mergers and acquisitions. Mike is a graduate of the City College of New York and New York Law School, and is admitted to practice in the Southern District and the Second Circuit.

The Firm is also pleased to announce that as of January 1, 2004, Albert L. Lingelbach and Joseph Michaels IV, the remaining Partners of Jackson & Nash, LLP, joined the Firm as Partners. Jackson & Nash, LLP was a smaller New York general practice firm that traced its history back to 1871 and, since September, 2003, had been sharing quarters with the Dunnington Firm on our 27th floor.

Albert L. Lingelbach graduated from the Wharton School of Finance and Commerce at the University of Pennsylvania and its School of Law. He has practiced as a Trusts and Estates attorney since 1965, lectured on estate planning topics and served as a member of various practice-oriented committees. Al is an important addition to the Firm's Estates, Trusts and Private Clients practice group where his practice emphasizes estate and trust planning and administration, the drafting of Wills and trusts, and estate and gift tax matters.

Joseph Michaels IV graduated with a degree in Accounting from the Wharton School of Finance and Commerce and from the Boston University School of Law. Joe received an LLM in Taxation from New York University School of Law. He works in a variety of practice areas, including individual and corporate taxation, charitable planning, qualified pension and profit-sharing plans, ERISA compliance, executive compensation, trusts, estates and individual planning and the representation of closely-held corporations and shareholders. Joe will provide services to clients in both the Estates, Trusts and Private Clients and the Corporate practice areas of the Firm.

The Firm also welcomes Associates Gayle Taylor, Emilie Baser and Bridget La Rosa, and legal assistants Fran Carnovale and Joann Moorhead. Gayle works primarily on general corporate and transactional matters, and Emilie provides support for several of the Firm's practice groups. Bridget and Joann join us from Jackson & Nash, and will continue to work on the administration of estates and trusts along with Fran, as well as real estate and individual client matters.